Just like other commodities, currencies are traded in a market known as the foreign exchange market. Globalisation of trade has necessitated the establishment of a platform through which currencies can be traded to facilitate international transactions. The exchange rate is either determined by the market forces or fixed by the government. The rate determined by the supply and demand forces is known as a freely floating rate. In this case, factors that influence the demand and supply of currency impact the exchange rate. The Kenyan currency is free floating that leads to fluctuations in line with changes in market forces.
Factors Affecting the Kenya Shilling Exchange Rate
The value of a free floating currency increases when the demand increases and loses value when its supply increases. To understand the Kenya shilling exchange rate, it is imperative to examine the factors that influence the currency’s demand and supply.
Exports and speculators are the primary forces that increase the demand of a currency. High demand for a country’ exports in the international market increases the demand for its currency to enable foreigners to pay for the exports. In 2017, Kenya’s exports amounted to $5.75 billion where the main export items were agricultural products, minerals, and apparels. Besides the exports, speculators increase the demand for a currency especially when they foresee the appreciation of its value. Since 2015 the value of Kenya shilling has been increasing where its exchange rate against the dollar has dropped from Ksh 106/US$ to an average of ksh100/US$.
The supply of a currency is determined by the demand for imports. Kenya’s balance of payment is skewed where the value of imports exceeds the exports by far. This trend has been increasing the supply of the Kenyan shilling in forex market that puts downward pressure on its value. Importers sell the Kenyan currency to acquire foreign currencies to enable them to pay for the imports. The impact of external borrowing on Kenya shilling exchange rate cannot be ignored. In the past, the country’s appetite for external borrowing has increased. Meeting the external debt obligation requires the government to sell the Kenya shillings to acquire other currencies thus increasing the Kenya shillings supply in the foreign exchange market.
Interest rate and political stability have direct impacts on the demand and supply of a currency. A high interest rate attracts foreign investors that in turn increase the demand for the local currency. Equally, political stability attracts foreign investors thus increasing the value of a currency.